1. Explain the concept of deferred taxes in financial accounting. How are deferred tax assets and deferred tax liabilities created? Provide examples of events or transactions that lead to the recognition of deferred taxes.
Question
- Explain the concept of deferred taxes in financial accounting. How are deferred tax assets and deferred tax liabilities created? Provide examples of events or transactions that lead to the recognition of deferred taxes.
Solution
The concept of deferred taxes in financial accounting refers to the recognition and measurement of taxes that will be paid or received in future periods as a result of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and their tax bases.
Deferred tax assets are created when the tax base of an asset or liability is higher than its carrying amount, resulting in a future tax benefit. This can occur when there are deductible temporary differences, such as tax losses or unused tax credits, that can be utilized to reduce future taxable income. For example, if a company has incurred tax losses in a particular year, it can carry forward those losses to offset future taxable income and reduce its tax liability.
Deferred tax liabilities, on the other hand, are created when the tax base of an asset or liability is lower than its carrying amount, resulting in a future tax obligation. This can occur when there are taxable temporary differences, such as the accelerated depreciation of an asset for tax purposes compared to its straight-line depreciation for financial reporting purposes. In this case, the company will have to pay higher taxes in the future when it recovers the asset's carrying amount for tax purposes.
To illustrate the recognition of deferred taxes, let's consider an example. Company A purchases a machine for 8,000, but its tax base is $6,000.
In this scenario, Company A would recognize a deferred tax liability of 2,000 temporary difference multiplied by the tax rate) because it will have to pay higher taxes in the future when it recovers the carrying amount of the machine for tax purposes.
Overall, deferred tax assets and liabilities are created when there are temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and their tax bases. These differences can arise from various events or transactions, such as tax losses, unused tax credits, or differences in depreciation methods.
Similar Questions
A taxable temporary difference leads to the payment of: Reading required: Learning objective 13.5: calculate and account for deferred income tax.Group of answer choicesmore tax in the future and gives rise to a deferred tax asset.more tax in the future and gives rise to a deferred tax liability.less tax in the future and gives rise to a deferred tax liability.less tax in the future and gives rise to a deferred tax asset.
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Preparing financial statements on the basis of recognising transactions when they occur is referred to as:financial accounting.management accountingaccrual accounting.cash accounting.
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